A partnership or sole proprietorship can limit its liability by using an entity for financial reporting called a limited liability company, or LLC. First established in the U.S. about 30 years ago, LLCs didn't become popular until the mid-1990s, when most states approved them.
This business form actually falls somewhere between a corporation and a partnership or sole proprietorship in terms of protection by the law. Because LLCs are state entities, any legal protections offered to the owners of an LLC are dependent on the laws of the state where it's established.
In most states, LLC owners get the same legal protection from lawsuits as the federal law provides to corporations, but unlike the federal laws, these protections haven't been tested fully in the state courts.
Reporting requirements for LLCs aren't as strict as they are for a corporation, but many partnerships do decide to have their books audited to satisfy all the partners that the financial information is being kept accurately and within internal control procedures determined by the partners.
Taking stock of taxes
LLCs let sole proprietorships and partnerships have their cake and eat it, too: They get the same legal protection from liability as a corporation but don't have to pay corporate taxes or file all the forms required of a corporation. In fact, the IRS treats LLCs as partnerships or sole proprietorships unless they ask to be taxed as corporations by using Form 8832, “Entity Classification Election.”
Reporting requirements
The issues of business formation and business reporting are essentially the same for a partnership and a sole proprietorship, whether or not the entity files as an LLC. To shield themselves from liability, many large legal and accounting firms file as LLCs rather than take the more formal route of incorporating.
When LLCs seek outside funding, either by selling shares of ownership or by seeking loans, the IRS requires their financial reporting to be more formal. Some partnerships form as LLPs, or Limited Liability Partnerships. In an LLP, one partner is not responsible for the other partner's actions. In some countries, an LLP must have at least one general partner with unlimited liability.
